Sep.	24,	2015

BY	EMAIL

Office	of	Exemption	Determinations

Employee	Benefits	Security	Administration

United	States	Department	of	Labor

122	C	St.	NW,	Ste.	400

Washington,	D.C.	20001

Office	of	Regulations	and	Interpretations

Employee	Benefits	Security	Administration

United	States	Department	of	Labor

200	Constitution	Ave. NW

Washington,	D.C.	220210

RE:	Docket	ID	EBSA-2014-0016;	RIN	1210-AB32

Attn:	Conflict	of	Interest	Rule,	Room	N–5655;	D-11712

Dear	Sir	or	Madam:

Fund	Democracy	greatly	appreciates	the	opportunity	to	submit	additional	

comments on	the	Department’s	proposed	Best	Interest	Contract	Exemption	(“BIC	

exemption”).

1 During	the	last	two	decades,	the	conflicted	structure	of	broker-dealer	

compensation	has	deteriorated	to	the	point	where	it	is	an	annual,	multi-billion	

dollar	drain	on	our	economy.		Securities	regulators	have	repeatedly	floated	

proposals	to	address	these	concerns	but	have	in	every	case	failed	to	followthrough,2 leaving	the	Department,	with	its	unique	mandate	to	protect	Americans’	

retirement	security	and	to	apply	the	heightened	legal	duties	that	ERISA	requires,	no	

choice	but	to	take	decisive	action.		I	applaud	the	Department	for	its	untiring	

diligence	through	a	long	rulemaking	process	and	unwavering	stand against	an	

unprecedented	onslaught	by	paid	lobbyists	and	self-interested	firms.

This	letter	reflects	more	than	two	decades of	experience,	covering	a	wide	range	of	

professional	perspectives, with	the	issues	addressed	by	the	Department’s proposed	

																																																							 1 I	am	the	founder	and	president	of	Fund	Democracy,	a	non-profit	organization	formed	in	2000	to	

advocate	on	behalf	of	investors.		I	do	not	receive	and	have	never	received	any	payments	from	Fund	

Democracy	other	than	reimbursement	of	out-of-pocket	expenses.		I	am	currently	a	law	professor	at	

the	University	of	Mississippi	School	of	Law	and	a	vice	president	of	a	St.	Louis-based	financial	

planning	firm.	

2 See Attachment	at	5	– 8.
2

BIC	exemption	and	related	proposals.

3 Since	submitting	my	first	comments,	I	have	

submitted a	written	statement	to	the	Department	pursuant	to	its	public	hearings	in	

August	and	written	testimony	to	the	House	Financial	Services	Committee’s	

Subcommittees	on	Capital	Markets	and	Government	Sponsored	Enterprises,	and	

Oversight	and	Investigations.		My	testimony,	which	is	most	relevant	here	with	

respect	to	its	discussion	of	three	alternative	proposals	floated	by	industry	

participants	and	lobbyists,	is	attached	to	this	letter	and	hereby	incorporated by	

reference.

This	letter	addresses	the Department’s	proposal	to	excuse non-security	annuities	

(“fixed	annuities”)	from	compliance	with	the	contract	requirement in	the	BIC	

exemption.		In	short,	excusing	fixed	annuities from	the	BIC	requirement	is	illadvised	in	light	of	both	the	frequency	of	sales	abuses	in	the	sale	of	fixed	annuities,	

specifically, indexed	annuities,4 and	the	exempt	status	of	indexed	annuities	under	

the	federal	securities	laws.	 As	noted	by	the	North	American	Securities	

Administrators	Association,	

Equity-indexed	annuities	are	extremely	complex	investment	products	

that	have	often	been	used	as	instruments	of	fraud	and	abuse.	For	

years,	they	have	taken	an	especially	heavy	toll	on	our	nation’s	most	

vulnerable	investors,	our	senior	citizens	for	whom	they	are	clearly	

unsuitable.5

																																																							 3 I	have worked	on	these	issues	in	many	capacities	over	the	last	25	years,	including	testifying	before	

Congress,	submitting	comment	letters,	publishing	commentaries,	delivering	presentations,	providing	

consulting	services,	acting	as	an	expert	witness	in	private	litigation	and	public	enforcement	matters	

(including	revenue	sharing	cases	brought	by	the	California	Attorney	General	and	Massachusetts	

Secretary	of	States’	Securities	Division),	developing	policy	as	an	Assistant	Chief	Counsel	at	the	SEC,	

advising	broker-dealers	in	private	practice	on	compliance	matters,	teaching	law	classes	and	in	

working	for	a	St.	Louis-based	financial	planner.		I	am	not	being	compensated	in	any	way	for	these	

comments,	and	I	believe	my	comments	reflect	an	objective	view	of	the	best	interests	of	investors.		I	

have	a	conflict	of	interest,	however,	in	that	the	Department’s	proposal	may	require	substantial	

changes	in	the	practices	of	the	registered	investment	adviser	that	employs	me.		The	Department	

should	assume	that	the	same	principles	that	I	recommend	be	applied	to	broker-dealers	should	be	

applied	equally	to	investment	advisers.		My	comments	are	focused	only	on	broker-dealer	issues	due	

to	time	constraints	and	because	that	is	where	the	Department’s	proposal	will	have	the	greatest	effect.	

4 See	generally	Investor	Alerts:	Equity-Indexed	Annuities	– A	Complex	Choice,	FINRA	(2015)(equityindexed	annuities	(“EIAs”) “are	anything	but	easy	to	understand.	.	.	.	investors	will	find	it	difficult	to	

compare	one	EIA	to	another)	available	at https://www.finra.org/investors/alerts/equity-indexedannuities_a-complex-choice;	Indexed	Annuities,	FINRA	(2015)	(“A	sales	representative	may	describe	

an	indexed	annuity	as	a	simple	and	easy-to-understand	product.”)	available	at

https://www.finra.org/investors/indexed-annuities.		Notice	to	Members:	Equity-Indexed	Annuities,	

FINRA	(August	2005)	(FINRA	“is	concerned	about	the	manner	in	which	associated	persons	are	

marketing	and	selling	unregistered	EIAs;”	providing	examples	of	misleading	adviser	claims	regarding	

indexed	annuities)	available	at	

https://www.finra.org/sites/default/files/NoticeDocument/p014821.pdf.

5 NASAA	Statement	on	SEC	Equity-Indexed	Annuity	Rule	(Dec.	17,	2008)	available	at	

http://www.nasaa.org/5611/nasaa-statement-on-sec-equity-indexed-annuity-rule/.	See	also Tricks	of	
3

Excusing	indexed	annuities from	the	BIC	requirements	would	further	weaken

regulation	where	regulation	is	already	weak	and	the	need	for	enhanced	investor	

protection	is	heightened.		I	strongly	encourage	the	Department	to	apply	the	same	

rules	to	indexed	annuities	as	it	proposes	to	apply	to	other	types	of	assets.

Background

The	Department	has	created	an	exemption,	the	BIC	exemption,	that	requires	that	

firms that	rely	on	the	exemption enter	into	a	contract	with	investors	that	provides

that,	inter	alia:	

(2)	The	Financial	Institution	has	adopted	written	policies	and	

procedures	reasonably	designed	to	mitigate	the	impact	of	Material	

Conflicts	of	Interest	and	ensure	that	its	individual	Advisers	adhere	to	

the	Impartial	Conduct	Standards	set	forth	in	Section	II(c);

(3)	In	formulating	its	policies	and	procedures,	the	Financial	

Institution	has	specifically	identified	Material	Conflicts	of	Interest	and	

adopted	measures	to	prevent	the	Material	Conflicts	of	Interest	from	

causing	violations	of	the	Impartial	Conduct	Standards	set	forth	in	

Section	II(c);	and

(4)	Neither	the	Financial	Institution	nor	(to	the	best	of	its	knowledge)	

any	Affiliate	or	Related	Entity	uses	quotas,	appraisals,	performance	or	

personnel	actions,	bonuses,	contests,	special	awards,	differential	

compensation	or	other	actions	or	incentives	to	the	extent	they	would	

tend	to	encourage	individual	Advisers	to	make	recommendations	that	

are	not	in	the	Best	Interest	of	the	Retirement	Investor.	

Notwithstanding	the	foregoing,	the	contractual	warranty	set	forth	in	

this	Section	II(d)(4)	does	not	prevent	the	Financial	Institution	or	its	

Affiliates	and	Related	Entities	from	providing	Advisers	with	

differential	compensation	based	on	investments	by	Plans,	participant	

or	beneficiary	accounts,	or	IRAs,	to	the	extent	such	compensation	

would	not	encourage	advice	that	runs	counter	to	the	Best	Interest	of	

the	Retirement	Investor	(e.g.,	differential	compensation	based	on	such	

neutral	factors	as	the	difference	in	time	and	analysis	necessary	to	

provide prudent	advice	with	respect	to	different	types	of	investments	

would	be	permissible).

																																																																																																																																																																				

the	Trade,	Dateline	NBC	(Apr.	13,	2008)	(hidden	camera	documentation	of	indexed	annuity	sales	

abuses)	available	at http://www.nbcnews.com/id/24095230/ns/dateline_nbc/t/trickstrade/#.VgRxlGRViko.		
4

The	Department	proposes	to	exempt	fixed annuities	from	these	requirements	as	

well	as	the	requirement	that	firms	enter	into	a	Best	Interest	Contract	with	investors.		

The	Department’s	rationale for	that	proposal	is,	in	part,	the	perceived:

uncertainty	as	to	whether	the	disclosure	requirements	proposed	

herein	are	readily	applicable	to	insurance	and	annuity	contracts	that	

are	not	securities,	and	whether	the	distribution	methods	and	channels	

of	insurance	products	that	are	not	securities	fit	within	this	

exemption’s	framework.

However,	the	Department	provides	no	further	explanation	of	why	it	believes	such	

uncertainty	exists.		

Indexed and	Variable Annuities	Raise	Similar	Conflicted	Compensation	Issues

In	my	view,	there	is	no	material	distinction	between	conflicted	compensation	

practices	as	they	relate	to	variable	and	indexed	annuities.		Financial	advisers	are	

typically	paid	a	commission	for	each	product,	with	additional	compensation	being	

paid	if	features	in	addition	the	product’s	core	features	are	sold.		For	example,	a	rider	

that	guaranteed	a	minimum	return	over	the	life	of	a	variable	annuity	that	would	

generate	additional	revenues	for	the	issuer	would	result	in	the	adviser	being	paid	

more	than	if	the	variable	annuity	were	sold without	the	rider.		An indexed	annuity	

will	necessarily	have	fewer	variations	than	a	variable	annuity	at	least	because	the	

former	does	not	entail	an	investment	in	a	portfolio	of	underlying	assets.		My	

understanding	is	that	indexed	annuities	typically	offer	few	add-ons	than	variable	

annuities,	but	this	does	not	affect	the	issue	of	whether, if	additional compensation	is	

paid for	such	add-ons,	this	compensation	structure	creates	an improper conflict.		In	

addition,	the	compensation	paid	to	advisers	for	selling	indexed annuities	may	vary	

from	and	is typically	higher	than the	compensation	received	for	sales	of	other	

products,	which	means	that	advisers	may	have	an	incentive	to	recommend	them	

solely	on	the	basis of	the	relative	compensation	received.		Indexed	annuity	

compensation	differentials	should	be	subject	to	the	same	requirement	that	the	firm	

have	some	rational	basis	for	paying	higher	selling	compensation	other	than	simply	

to	promote	sales.		In	my	view,	the Department	has	not	provided	a reasonable	basis	

for	excusing	indexed	annuities	from	the	BIC	requirement.	

Applying	the	BIC	Exemption	to	Indexed	Annuities	Would	Be	

Eminently	Workable

As	noted	by	the	Department,	the	BIC	exemption	“does	not	mandate	the	specific	

content”	of	a	firm’s policies	and	procedures,	but	rather	“allow[s]	Financial	

Institutions	to	develop	policies	and	procedures	that	are	effective	for	their	particular	

business	models,	within	the	constraints	of	their	fiduciary	obligations	and	the	

Impartial	Conduct	Standards.”	 Requiring	appropriate	policies	and	procedures	for	

sales	of	indexed	annuities	would	similarly	allow	firms	to	develop	policies	and	
5

procedures	that	were	tailored	to	their	particular	business	models	and	the	

characteristics	of	the	product.	

Similarly,	the	BIC	exemption	would	prohibit	compensation	practices	that	“tend	to	

encourage”	recommendations	that	are	not	in	the	client’s	best	interest.		Like	the	

policies	and	procedures	requirement,	this	principles-based	approach	will	allow	

firms	to	tailor	their	compensation	structures	to	their	particular	business	models	and	

the	products	they	sell.		The	“tend	to	encourage”	standard	would	allow	sellers	of	

indexed annuities	to	adopt	policies	and	procedures	that	reflect	the	particular	

characteristics	of	these	products.		

The	Department	observes	that	paying	higher	compensation	for	variable	annuities	

can	be	justified	on	the	basis	of	the	financial	advisers’	additional	investment	time	and	

analysis.	 This	position	is	equally	applicable	to	sales	of	indexed annuities.		The	

Department	provides	four	examples	of	compliant	practices,	each	of	which	could	

easily	be	applied	in	the	indexed	annuity	context.		The	Department	identifies	six	

examples	of	procedures	that	would	mitigate	or	eliminate	abusive	conflicts,	each	of	

which	is	no	less	appropriate	in	the	context	of	indexed annuities.		There	is	simply	no	

basis	for	concluding	that entering	into	the	Best	Interest	Contract	would	be	

materially	more	onerous	for	indexed	annuities, or	that IRA	investors	are	entitled	to	

less	protection	from	conflicted	sales	of	indexed	annuities	than	conflicted	sales	of	

other	products.

Indexed	Annuity	Sales	Practices	call	for	More Investor	Protection,	Not	Less

In	fact,	IRA	investors	are	in	need	of	greater	protection	in	the	context	of indexed

annuities.		As	discussed	below,	a	number	of	factors	militate	for	imposing	higher	

standards	of	conduct	with	respect	to	sales	of	indexed	annuities	because these	

products	are:	(1) subject	to	less	non-ERISA	regulation,	(2)	more	susceptible	to	

abusive	sales	practices,	and	(3)	more	likely	to	be	sold	by	financial	advisers	whose	

primary	concern	is	their	own	compensation	rather	than	their	clients’	best	interest.	

For	example,	indexed	annuities	are	not	subject	to	FINRA’s	compliance	requirements	

or	suitability	standard.		The	policies	and	procedures	required	by	the	BIC	reflect	

FINRA’s	requirement	that	broker-dealers	adopt	policies	and	procedures	that	are	

designed	to	mitigate	conflicts	of	interest.6 However,	FINRA’s	policies	and	

procedures	requirements	do	not	apply	to	sales of	non-securities	such	as	indexed

annuities.	 Thus,	the	Department	proposes	to	exempt	the	same	category	of	IRA	

assets	from	the	BIC’s	policies	and	procedures	requirements	that	are	already	exempt	

from	FINRA	compliance	requirements.		While	mutual	fund	and	variable	annuity	

sales	are	subject	to	two	layers	of	policies	and	procedures	requirements,	indexed	

annuities	are	subject	to	neither.		The	need	for	effective	policies	and	procedures	to	

																																																							 6 See generally Report	on	Conflicts	of Interest,	FINRA	(October	2013)	(“Report	on	Conflicts	of	

Interest”)	available	at	http://www.finra.org/sites/default/files/Industry/p359971.pdf.
6

mitigate	conflicts	in	the	sale	of	indexed	annuities	is	greater	than	for	other	products,	

yet	the	Department	proposes	to	subject	these	sales	to	lower	rather	than	higher	

standards.	

In	its	most	recent	interpretation	of	the	suitability	standard,	FINRA	made	it	clear	that	

a	suitability	violation	can	be	based	on	excessive	or	conflicted fees,	which	is	

consistent	with	the	BIC’s	prohibition	against	providing	compensation	that	“tends	to	

encourage”	advice	that	is	not	in	the	client’s	best	interest.		Both	standards	will	apply	

to	mutual	fund	and	variable	annuity	sales because	those	products	are securities,	but

neither	standard	will	apply	to	indexed annuity	sales.		Again,	the	Department	

proposes	to	excuse	indexed annuities	from	BIC	requirements	where	the	absence	of	

securities	regulation calls	for	heightened	regulation.	

There	is	no	material	difference	between	the	conflicted	compensation	issues	that	

arise	in	the	context	of	variable	annuities	and	indexed annuities.		Variable	annuities	

often	include	an	array	of	riders	and	other	special	benefits	that	trigger	higher	

compensation	for	financial	advisers.		For	variable	annuities,	financial	advisers	will	

have	to	make	determinations	regarding	when	higher	compensation	is	justified	

based	on	the	time	and	analysis	they	have	invested	in	the	recommendation.		The	

same	kind	of	evaluation	should	be	required	for	indexed	annuities.		In	my	view,	there	

is	no	reasonable	basis	for	distinguishing	variable	annuities	and	indexed	annuities	in	

terms	of	the	structure	of	financial	advisers’	selling	compensation or	the	procedures	

that	would	be	required	to	comply	with	the	BIC	exemption.		

Excusing	indexed	annuities	from	the	BIC	requirements will	grossly	distort	financial	

advisers’	selling	incentives and	harm	investors.	 Indexed	annuities,	like	variable	

annuities, already	represent	a	disproportionate	share	of	abusive	sales	practices.		

They	pay	higher	compensation	to	financial	advisers	than	other	products	and	

therefore	attract	financial	advisers	who	are	more	inclined	to	sell	on	the	basis	of	

compensation	than	the	client’s	best	interest.		They	are	often	unsuitable	investments,	

particularly	when	placed	in	a	tax-deferred	wrapper	such	as	an	IRA,	a	factor	that	the	

Department	should	specifically	address.

7		Securities	regulators	have	become	

increasingly	permissive	with	respect	to	unsuitable sales of	annuities,	which	has	

contributed	to	skyrocketing	unsuitable	sales	of	these	products	in	IRAs.		From	2000

to	2012,	sales	of	variable	annuities	and	indexed	annuities	rose	from	41%	to	62%	

																																																							 7 The	Department	proposes	to	ban	municipal	securities	from	IRAs	because	they	are	virtually	never	

appropriate	investments	in	a	tax-deferred	wrapper,	but	it	does	not	anywhere	address	the	same	issue	

for	annuities.		I	note	that	this	is	actually	a	more	significant	problem	in	the	retirement	plan	context,	

where	assets	are	often	invested	in	variable	annuities	in	which	the	only	non-investment	feature	is	the	

guaranteed	annuity	rate	at	termination.		The	Department	should	address	the	question	of	how	merely	

offering	retirees	the	right	to	annuitize	can	rationally	justify	the	higher	fees	paid	by	plan	participants	

for	these	products,	when	participants	could	annuitize	their	plan	balance	just	as	easily	(and	as	often	as	

not	more	cheaply)	after	rolling	over	their	accounts	into	an	IRA	or	by	choosing	a	fixed	income	annuity	

offered	by	the	plan.
7

and	49%	to	61%,	respectively.8		These	data	are	consistent	with	advisers	

increasingly advising	investors	to	roll	over their	401(k)	assets	into	variable	and	

indexed	annuities, yet	the	Department	would	excuse indexed	annuities	from	BIC

requirements.	

The	indexed annuity	exemption	problem	is	exacerbated	because	financial	advisers	

seeking	to	evade	investor	protection	requirements	have	an	additional	incentive	to	

sell	indexed	annuities	because	their	abusive	sales	practices	will	not	be	subject	to	

securities	regulation.		These	are	precisely	the	advisers	who	are	most	likely	to	engage	

sales	abuses	and	be	attracted	to	sales	of	higher	compensation	products	solely	on	the	

basis	of	compensation.		These	are	likely	the	same	advisers	who	are	primarily	

responsible	for	abusive	sales	practices	in	the	non-traded	REIT	market.		The	

Department	has	correctly	concluded	that	sales	abuses	with	respect	to	non-traded	

REITs	have	been	so	prevalent	that	these	products	cannot	be	permitted	to	be	sold	in	

IRAs.		Yet	the	advisers	who	sell	these	products	are	likely	to	shift	their	non-traded	

REIT book	of	business	to	high-compensation	indexed	annuities,	and	the	

Department’s	exemption	would	give them	an	additional	incentive	to	do	so.

Finally,	the	Department’s	indexed	annuity	exemption	will	exacerbate	sales	practices	

abuses	by	driving	more	IRA	assets	into	the	hands	of	advisers	who	are	not	subject	to	

any	securities	regulation.		At	least	advisers	employed	by	broker-dealers	will	

continue	to	be	subject	to	their	firms’	securities-law-based	regulatory	structures,	

even	if	their	specific	sales	of	fixed	annuities	are	not	specifically	subject	to	securities	

regulation.		In	contrast,	insurance	agents	that	are	not	dually	registered	are not	

reached	by	securities	regulation	in	any	way.		This	makes	a	significant	difference	in	

the	fixed	indexed	annuity	market	because	that	market	is	dominated	by	independent	

insurance	agents.		Whereas	independent	insurance	agents	account	for	only	1%	of	

sales	of	variable	deferred	annuities,	they	account	for	82%	of	sales	of	indexed	

deferred	annuities.9		The	Department’s	indexed	annuities	exemption	therefore	will	

have	the	effect	of	pushing	IRA	investors	into	the	hands of	less	regulated	insurance	

agents	whose	sales	standards	are	even	lower	than	FINRA’s	suitability	standard.		

*		*		*		*		*		*		*		*		*

In	summary,	the	Department	proposes	to	create	an	exemption	and	weaken	investor	

protections	where	it	should	impose	additional	requirements	and	strengthen	

investor	protection.		The	Department’s	excusing	indexed	annuities	from	the	BIC	

requirements takes	an	approach	that	is	the	direct	opposite	of	the	approach	it	should	

take	to	what	are	probably,	with	the	sole	exception	of	non-traded	REITs,	the	IRA	

assets	that	are	most	frequently	associated	with	abusive	sales	practices	and	

																																																							 8 See Joseph	Montminy,	The	Changing	Individual	Annuity	Market at	10,	LIMRA	(2013)	available	at

https://s3.amazonaws.com/presspublisher-do/upload/567/2013_RIC_Session_2.1_-

_Annuity_Market_Trends_-_Montminy.pdf (last	visited	Sep.	24,	2015).

9 Id.	at	8.
8

unsuitable	recommendations.		The	exemption	will	have	the	effect	of	increasing	sales	

of	less-regulated	indexed	annuities,	which	the	most	compensation-sensitive	

financial	advisers	will	be	incentivized	to	sell	instead	of	better	regulated	mutual	

funds and	variable	annuities	and	to-be-banned	non-traded	REITs.

In	my	view,	the	Department’s	core	proposal	is	sound and	holds	out	the	potential	to	

create	substantial	benefits	for	investors,	but	the Department’s	indexed	annuity	

exemption	may	simply	make	a	bad	situation	worse. I	strongly	encourage	the	

Department	to	remove	the	indexed	annuity	exemption	or	at	least	to	incorporate	the	

BIC’s	policies	and	procedures	and	“tend	to	encourage”	warranties	in	PTE	84-24.

Thank	you	again	for	the	opportunity	to	comment	on	the	Department’s	proposal.		I	

would	be	pleased	to	discuss	these	comments	or	related	issues	with	the	Department	

staff	and	may	be	contacted	at	662-915-6835 or	mbullard9@gmail.com.	

Respectfully,	

Mercer	Bullard

Attachment:	as
Testimony of Mercer E. Bullard

President and Founder, Fund Democracy, Inc.

and

MDLA Distinguished Lecturer and Professor of Law

University of Mississippi School of Law

before the

Subcommittees on 

Capital Markets and Government Sponsored Enterprises, 

and Oversight and Investigations

Committee on Financial Services

United States House of Representatives

Preserving Retirement Security and Investment Choices 

for All Americans

September 10, 2015
2

Chairman Garrett, Ranking Member Maloney, Chairman Duffy, Ranking Member 

Green, members of the Subcommittee, it is an honor and a privilege to appear before the 

Subcommittee today. Thank you for this opportunity. I am the Founder and President of 

Fund Democracy, a nonprofit advocacy group for investors, and a Professor of Law at the 

University of Mississippi School of Law. This testimony discusses H.R. 1090 in Part I 

and the Department of Labor’s proposed exemption from prohibited transaction rules for 

Individual Retirement Accounts (“IRAs”) in Parts II - IV. 

In summary, I do not support H.R. 1090. As discussed in Part I.A, Section 2 

would prevent the Department from completing its long overdue rulemaking by making 

that rulemaking contingent on prior, unrelated rulemaking by the Securities and 

Exchange Commission (“SEC” or “Commission”) under Section 913 of the Dodd-Frank 

Act. Investors would continue to experience losses resulting from financial advisers’ 

incentives to make recommendations that are not in investors’ best interest, with no 

guarantee that the Commission would ever adopt rules under Section 913. As explained 

in Part IB, it is unreasonable to make any rulemaking contingent on SEC action in view 

of the SEC’s longstanding rulemaking paralysis. Section 3 of H.R. 1090 would require 

unnecessary, redundant and burdensome reports and analysis by the Commission and 

would be inconsistent with APA principles of notice and comment, as I discuss in Part 

I.C. 

I strongly support the Department’s proposal and urge Congress to take proactive 

steps to help the Department finalize its rulemaking. The Department’s proposal to treat 

financial advisers who make investment recommendations to investors as fiduciaries will 

help protect investors from abusive sales practices and conflicted compensation 

arrangements. Fiduciary status will cause broker-dealers and financial advisers to violate 

certain prohibited transaction rules as a result of conflicted compensation arrangements 

that make the amount of an adviser’s compensation depend on the recommendation made

by the adviser. However, the Department has proposed exemptions from the prohibited 

transaction rules that are both workable for the industry and effective in protecting 

investors. 
3

The adverse effect of conflicted compensation arrangements is indisputable. Just 

as it is a fundamental law of economics that if you tax an activity you will get less of it, it 

is a fundamental law of economics that if you pay for more certain recommendations, 

you will get more of them. For example, if you pay your financial advisers more for 

selling stock funds than short-term funds, which is standard industry practice, more stock 

funds will be sold than if advisers’ compensation was the same for both funds. I discuss 

the pervasive effect of conflicted compensation arrangements in Part II.

The financial services industry claims that the Department’s proposal cannot 

work. In fact, the proposal is eminently workable. Industry claims are based on 

erroneous assumptions regarding how the proposal would operate in practice. Part III of 

this testimony corrects the most common misperceptions regarding the proposal.

Industry claims are also belied by the fact that some broker-dealers have been able to 

implement workable compensation practices that comply with or even exceed the 

requirements of the Department’s proposal. For example, some broker-dealers have 

already mitigated conflicted compensation arrangements by: (1) eliminating financial 

advisers’ differential compensation for platform and proprietary funds, (2) capping 

commission compensation for financial advisers, (3) adopting product-neutral 

commissions and payout grids, (4) abjuring production-based payout grids altogether, and 

(5) limiting payout increases to prospective sales rather than also applying them 

retroactively. These and other current practices are both workable for broker-dealers and 

beneficial for investors. In Part IV, this testimony discusses certain alternatives to the 

Department’s proposals that have been offered by industry members. 

I. H.R. 1090

A. Section 2 of H.R. 1090 

Section 2 of H.R. 1090 prohibits the Department from completing its rulemaking until at 

least 60 days after the Commission has issued a final rule pursuant to Section 913 of the 

Dodd-Frank Act. I do not support Section 2 for a number of reasons.
4

• Conduct standards under the securities laws are lower than under ERISA. In 

ERISA, Congress expressly decided to impose higher standards of care and 

loyalty with respect to retirement assets than it imposed under the federal 

securities laws. Section 2 therefore conflicts with ERISA because it prevents the 

Department from imposing the higher standards that ERISA requires in deference 

to an agency that does not have the authority to impose such standards. 

• The securities laws regulate only securities, whereas ERISA covers all types of 

retirement assets. In ERISA, Congress expressly decided to regulate assets that 

are not securities and therefore not subject to the federal securities laws. Section 

2 therefore conflicts with ERISA because it prevents the Department from 

regulating non-securities in deference to an agency that does not have the 

authority to regulate non-securities.

• In ERISA, Congress specifically granted the Department authority over the 

regulation of retirement assets, including non-securities assets. The Commission 

does not have authority over the regulation of non-securities or authority over 

many types of retirement plans. Section 2 prevents the Department from 

exercising the authority Congress specifically required it to exercise in deference 

to an agency that does not have this authority. 

• The Department has not adopted any rules, it has only proposed rules. The 

Department has made it clear that it will makes changes to its proposal. Congress 

should not prevent the Department from adopting rules when it does not know 

what rules the Department may adopt. Section 2 broadly threatens the 

functioning of regulatory agencies and the principle of notice and comment by

judging, in effect, final rules without knowing what the final rules will be. It 

undermines the rule of law by interfering with the very process of administrative 

rulemaking. 

If Congress disagrees with the positions taken by the Department in its proposals, there 

are reasonable means for it to do so. It could, once there is actually a rule with which it 

can disagree, amend ERISA to change the legal standards that apply to retirement assets 

or narrow the scope of those legal standards. 

Section 2 is also inappropriate because it requires the Department to wait for an agency to 

adopt rules when the agency clearly will not do so. As discussed further below, the 

Commission has repeatedly acknowledged the problems that the Department’s proposal

addresses but chosen not to address them. Indeed, with respect to discretionary 

rulemaking the Commission has exhibited regulatory paralysis for more than a decade. It 

is unreasonable to condition the Department’s rulemaking on other rulemaking that will 
5

not happen in the foreseeable future. In this case, rulemaking delayed would be 

rulemaking denied.

B. Commission’s Rulemaking Paralysis

The Commission has proposed a number of rules, none of which it has been able to 

finalize, that address issues that provide much of the impetus for the Department’s 

rulemaking. In doing so, the Commission has demonstrated that it cannot be relied to 

take action under Section 913 of the Dodd-Frank Act or otherwise adopt rules to require 

adequate disclosure of conflicted compensation arrangements or to require procedures 

designed to eliminate or mitigate the adverse effect of these arrangements.

i. Revenue Sharing Payments

Since the 1990s, mutual fund companies have made distribution payments out of their 

management fees, yet there are no Commission rules that require disclosure of these 

payments, much less rules that address the conflicts of interest that differential revenue 

sharing payments create. Revenue sharing payments generally comprise a percentage of 

the transaction amount and an ongoing percentage of fund assets held at the brokerdealer. Industry participants have been sued by private parties, state securities regulators 

and the Commission itself regarding inadequate disclosure of revenue sharing 

arrangements, yet the Commission has been unable to set of clear standards for revenue 

sharing disclosure. 

The Commission proposed rules to address this issue in 2004 that would have mandated 

disclosure to investors at the time of the transaction (“point of sale”).1 It was unable to 

finalize this rulemaking. In 2010, the Department put the Commission on notice that it 

intended to regulate revenue sharing with respect to retirement assets. Also in 2010, the 

Dodd-Frank Act amended the Exchange Act to require the Commission to: 

 1 Confirmation Requirements and Point of Sale Disclosure Requirements for Transactions in Certain 

Mutual Funds and Other Securities, and Other Confirmation Requirement Amendments, and Amendments 

to the Registration Form for Mutual Funds, Rel. No. IC-26341 (Jan. 29, 2004). See also Point of Sale 

Disclosure Requirements and Confirmation Requirements for Transactions in Mutual Funds, College 

Savings Plans, and Certain Other Securities, and Amendments to the Registration Form for Mutual Funds, 

Rel. No. IC-26778 (Feb. 28, 2005) (requesting additional comments).
6

examine and, where appropriate, promulgate rules prohibiting or 

restricting certain sales practices, conflicts of interest, and compensation 

schemes for brokers, dealers, and investment advisers.2

Despite such patent invitations for the Commission to take action, the Commission has 

failed to promulgate rules. More than a decade after its point-of–sale proposal, the 

Commission has been unable to take final action on that rulemaking. It continues to 

regulate revenue sharing primarily through its enforcement program. 

ii. 12b-1 Fees

The Commission has conceded for more than 15 years that Rule 12b-1 was in dire need 

of reform. For example, the mutual fund confirmation shows the amount of the 

commission charged, but it does not show the 12b-1 fees that investors pay on an ongoing 

basis. This misleading omission has been exacerbated by the broker-dealer industry’s 

shift, over the last two decades, from commissions to asset-based fees. Commissions on 

mutual funds have steadily declined, while 12b-1 fees have increased and become the 

functional equivalent of a deferred or installment commission.

In 2008, SEC Chairman Christopher Cox promised that,

in coming days, you can look for the SEC to open up the hood of this old 

jalopy and start cleaning out the gunk. When the overhaul is done, I 

predict there won't be a 12b-1 in there anymore.3

The “coming days” became months, which became years. In 2010, the Commission 

finally proposed substantial reforms to 12b-1 fees,4 yet it has unable to take final action 

 2 Dodd-Frank Act Section 913(g) (adding new subparagraph (l) to Exchange Act Section 15).

3 Comments by Christopher Cox, Chairman, U.S. Securities and Exchange Commission, at the Investment 

Company Institute 4th Annual Mutual Fund Leadership Dinner, Washington, D.C. (Apr. 30, 2008) 

(“Chairman Cox Comments”) available at http://www.sec.gov/news/speech/2008/spch043008cc.htm.

4 See Mutual Fund Distribution Fees; Confirmations, Rel. No. IC-29367 at 15 – 16 (July 21, 2010) (“12b-1 

Fee Proposal”).
7

on that rulemaking. Seven years after Chairman Cox’s promise, and five years after 

proposing reforms, the SEC’s “pending repeal or reform of rule 12b-1”5 is still pending. 

iii. Mutual Fund Fixed Pricing 

Section 22(d) of the Investment Company Act requires that mutual funds sell their shares 

at the price stated in the prospectus. The effect of this requirement is to fix the 

commissions charged for purchasing shares of a given mutual fund, regardless of whether 

the broker-dealer responsible for the transaction would charge less for its services. Thus,

one reason that broker-dealers are paid differential commissions is that they cannot 

choose the commission level at which they wish to provide their services.

As the Commission has noted, Section 22(d) “effectively prohibits competition in sales 

loads on mutual fund shares at the retail level;” such anticompetitive price fixing “would 

normally be a violation of the antitrust laws.”6 In 2010, the Commission proposed to 

allow funds to sell shares for which broker-dealers determined the commission.7 

However, as has been the case with a number of initiatives, the Commission has been 

unable to close the deal. 

iv. Fiduciary Duty

Section 913 of the Dodd-Frank Act specifically authorizes the Commission to adopt rules 

that apply a fiduciary duty when broker-dealers provide personalized investment advice. 

Congress provided specific guidance regarding its intention that such rulemaking not 

prevent commission-based compensation or the sale of proprietary products while also 

expressing specific concern regarding: 

the provision of simple and clear disclosures to investors regarding the 

terms of their relationships with brokers, dealers, and investment advisers, 

 5 Chairman Cox Comments, supra.

6 12b-1 Fee Proposal, supra, at 87 & n.266 (citing U.S. v. National Ass’n of Sec. Dealers, Inc., 422 U.S. 

694, 701 (1975) (antitrust immunity is afforded to sales made pursuant to Section 22(d))). 

7 Id., passim. 
8

including any material conflicts of interest.

8

 

The SEC Chairman had promised to engage in such a fiduciary rulemaking even before 

the Section 913 was enacted, but more than five years after Section 913 became law no 

action has been taken. 

v. Conclusion

These examples reflect a pattern of acknowledging the problems that the Department now 

seeks to address but failing to take action to address them, as well as a broader regulatory 

paralysis exhibited by the Commission over last fifteen years. For example, when the 

Commission exempted certain broker-dealers from registration under the Advisers Act, it 

was unable to adopt a final rule until forced to do so by litigation years later. In the 

1990s, after the Commission permitted exchange-traded funds (“ETFs”) on the condition 

that they fully disclose their portfolios, and after issuing a concept release on actively 

managed ETFs in 2001,9 it took 14 years to permit the offering of a managed ETF that 

did not disclose its portfolio.

In 2003, the Commission proposed a rule that codified the terms of hundreds of multimanager exemptions, but no final action has been taken.10 Nor has the Commission 

adopted proposed Rule 6c-11, which was proposed seven years ago and would codify 

ETF exemptions.11 Both multi-manager fund and ETF sponsors therefore still must 

obtain individual exemptions. Giving new meaning to the word “temporary,” the 

Commission adopted a “temporary” exemption from principal trading provision of the 

 8 Dodd-Frank Act Section 913(g) (adding new subparagraph (l) to Exchange Act Section 15).

9 See Actively Managed Exchange Traded Funds, Rel. No. IC-25258 (Nov. 8, 2001). In 2015, the 

Commission requested comment on ETFs and other exchange-traded products. See Request for Comment 

on Exchange-Traded Products, Rel. No. 34-75165 (June 12, 2015).

10 See Exemption from Shareholder Approval for Certain Subadvisory Contracts, Rel. No. IC-26230 (Oct. 

23, 2003) available at https://www.sec.gov/rules/proposed/33-8312.htm.

11 See Exchange-Traded Funds, Rel. No. IC-28193 (Mar. 11, 2008). 
9

Advisers Act in 2007 with an expiration date of Dec. 31, 2009,12 which it has extended in 

violation of the APA in 2009, 2010, 2012 and 2014.13

In the 1990s, the Commission became aware of widespread market timing based on stale 

mutual fund prices, but it did nothing to stop such abuses until forced to do so, in effect, 

by the New York Attorney General. Similarly, the Commission sat by while analysts’ 

conflicts corrupted the investment banking industry until the New York Attorney General 

stepped in and forced major reforms. In 2007 and the first half of 2008, the growing 

short-term credit crisis provided obvious signals that money market funds (“MMFs”) 

were at risk. Requests for no-action relief to bail out funds had reached an all-time high, 

and funds that were structurally similar to MMFs failed or experienced runs.14 In January 

2008, my advocacy group submitted a rulemaking petition with other advocacy 

organizations asking the Commission to reconsider its ad hoc no-action process and to 

require MMFs to file electronically their portfolios with the Commission to enable the 

systematic review of MMF pricing accuracy.

15 The Commission took no action, and the 

Primary Reserve Fund failed in September 2008.

 12 See Advisers Act Rule 206(3)-3T; Temporary Rule Regarding Principal Trades with Certain Advisory 

Clients, Rel. No. IA-2653 (Sep. 24, 2007).

13 See Temporary Rule Regarding Principal Trades with Certain Advisory Clients, Rel. Nos. IA-3948 (Dec. 

17, 2014) (Dec. 31, 2016 expiration date), IA-3522 (Dec. 20, 2012) (Dec. 31, 2014 expiration date), IA3128 (Dec. 28, 2010) (Dec. 31, 2012 expiration date) & IA-2965 (Dec. 23, 2009) (Dec. 31, 2010 expiration 

date).

14 Financial Crisis Inquiry Report, National Commission on the Causes of the Financial Economic Crisis in 

the United States at 254 – 255 (January 2011)(at least 44 fund companies bought securities from their 

MMFs’ portfolios in late 2007) available at http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf. 

A $5 billion cash fund that was operated by GE similar to an MMF failed in late 2007, and a $27 billion 

state-run cash fund experienced a run in which $8 billion in assets were redeemed over a two week period. 

See id. at 255.

15 See generally Letter from Fund Democracy, Consumer Federation of America, Consumer Action, AFLCIO, Financial Planning Association, and National Association of Personal Financial Advisors to Nancy 

Morris, Secretary, U.S. Securities and Exchange Commission (Jan. 16, 2008) available at

http://www.sec.gov/rules/petitions/2008/petn4-554.pdf. 
10

In 2013, the Commission proposed investor protections in conjunction with adopting 

rules that permit issuers to advertise private offerings publicly.16 When the Commission 

issued the proposal, Chair Mary Jo White stated that she was:

firmly committed to keeping consideration of this proposal on track so that 

the Commission is able to make an appropriate and timely regulatory 

response to the operation of the new rule permitting general solicitation.17

Nonetheless, more than two years later the proposal is still pending.

In conclusion, it is per se unreasonable to make any regulatory action contingent on prior 

action by the Commission. Time and time again, the Commission has proposed rules and 

promised reforms but been unable to get the job done. 

C. Section 3 of H.R. 1090

Section 3 of H.R. 1090 requires that, prior to promulgating a rule under Section 2, the 

Commission conduct a study of broker-dealer and investment adviser regulation. It 

requires that, “alongside” the promulgation of such a rule the Commission publish certain 

findings regarding harm to and confusion among investors. It also requires the 

Commission, in proposing such a rule, to consider the differences in the regulation of 

broker-dealers and investment advisers. In principle, I generally agree that the 

Commission should consider the factors identified in Section 3 pursuant to any fiduciary 

rulemaking. However, I am opposed to this provision for a number of reasons.

Section 3 is redundant because the Commission has previously committed to complying 

with Executive Order 13563, which would require the reviews and consider the factors 

that Section 3 mandates.

18 That Order requires that agencies:

 16 Amendments to Regulation D, Form D and Rule 156, Rel. No. 33-9416 (July 10, 2013). The 

Commission also stated that it would “monitor and study the development of private fund advertising and 

undertake a review to determine whether any further action is necessary.” Eliminating the Prohibition 

Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Rel. No. 33-

9415 at 51 – 52 (July 10, 2013).

17 Statement of Mary Jo White, Chair, U.S. Securities and Exchange Commission (July 10, 2013) available 

at http://www.sec.gov/news/statement/2013-07-10-open-meeting-statement-mjw.html.

18 See Improving Regulation and Regulatory Review, Executive Order 13563 (Jan. 18, 2001). 
11

(1) propose or adopt a regulation only upon a reasoned determination that 

its benefits justify its costs (recognizing that some benefits and costs are 

difficult to quantify); 

(2) tailor its regulations to impose the least burden on society, consistent 

with obtaining regulatory objectives, taking into account, among other 

things, and to the extent practicable, the costs of cumulative regulations; 

(3) select, in choosing among alternative regulatory approaches, those 

approaches that maximize net benefits (including potential economic, 

environmental, public health and safety, and other advantages; distributive 

impacts; and equity); 

(4) to the extent feasible, specify performance objectives, rather than 

specifying the behavior or manner of compliance that regulated entities 

must adopt; and 

(5) identify and assess available alternatives to direct regulation, including 

providing economic incentives to encourage the desired behavior, such as 

user fees or marketable permits, or providing information upon which 

choices can be made by the public.19

Section 3 will complicate the administrative process and increase regulatory burdens and 

costs without providing any benefits. I also oppose H.R. 1090 for the following reasons. 

• The Commission has already conducted an exhaustive study of the broker-dealer 

and investment adviser regulatory regimes. The provisions of Section 913 already 

provide clear guidance and limits on the Commission’s rulemaking authority 

regarding a fiduciary duty for broker-dealers, such as the requirement that 

rulemaking not impede commission-based arrangements or the sale of proprietary 

products. The Commission already has indicated in its prior report that it intends 

to extend any fiduciary rulemaking to reconsideration of broker-dealer and 

investment adviser examination requirements. 

• Section 3 requires that the Commission satisfy certain requirements before it even 

issues a proposal, which means that critics may be able to challenge a proposal

before it has become final. This requirement undermines the notice and comment 

process and the foundation of administrative law. If this provision is adopted, it 

should clarify that the APA does not apply.

• Section 3 exacerbates the problems created by Section 2 because it places 

additional, improper impediments to the Department’s carrying out its statutory 

 

19 See id. 
12

duties by delaying further the Department’s rulemaking. In other words, it 

requires that a different agency make certain findings that may not even be 

relevant to a Department rulemaking, yet the Department rulemaking could not 

occur unless such irrelevant findings are made. 

• Section 3 improperly emphasizes investor “confusion.” Whether investors have a 

clear understanding of the legal duties owed to them by financial advisers is not 

the issue that a fiduciary duty addresses. A fiduciary duty comprises a standard of 

care and a standard of loyalty. Broker-dealers routinely hold themselves out and 

provide investment advice as financial advisers, and the law has for centuries held 

such professionals to a fiduciary duty, regardless and independent of their clients’ 

understanding of that duty.

• Section 3 would prevent the Commission from adopting rules unless it found that 

they reduce either “confusion or harm to investors . . . due to different standards 

of conduct” (the term “either” should be inserted in the provision for clarity). 

Harm to investors is not caused by different standards as such, it is caused by one 

or more standards being inadequate to protect investors. If a finding is required, it 

should be that the rule promulgated reduces harm or confusion. 

II. Conflicted Compensation Arrangements

Over the last few decades, broker-dealers have developed a wide variety of compensation 

structures that incentivize financial advisers to make recommendations that pay them the 

highest compensation. The kinds and effects of conflicted compensation are truly mindboggling. Differences in compensation often bear no relationship to the services 

provided. Instead, they seem to exist only to generate higher revenues for the minority of 

financial advisers who choose to serve investors by choosing to serve only themselves. 

Broker-dealers are paid part of the commission paid on a mutual fund purchase, part of 

which is paid to the financial adviser. For example, on a $10,000 purchase of the 

American Mutual Fund, an investor would pay a 5.75% commission ($575), of which the 

funds’ distributor would pay 5.00% ($500) to the selling broker-dealer (the “gross dealer 

concession,” or “GDC”), which would generally pay its financial adviser from 20% 

($100) to 100% ($500) of that amount. The payment to the financial adviser is typically 

based on a “payout grid” that pays the adviser a percentage of the GDC. A typical payout 

would be 40% ($200). I have assumed a 40% payout in the examples provided below. 
13

If the investor were a 70-year-old retiree, it usually would not be appropriate to invest 

100% of her $10,000 in a stock fund. However, the adviser would be paid less if part of 

the investment were placed in a bond fund or short-term bond fund. For example, if 

$5,000 of the $10,000 investment were invested in The Bond Fund of America, the 

commission would be only 3.75% ($187.50), the GDC only 3.00% ($150), and the 

financial adviser’s payment only $60. If $5,000 were invested The Short-Term Bond 

Fund of America, the commission, GDC and adviser’s payout would be, respectively, 

2.50% ($125), 2.00% ($100) and $40. In other words, the financial adviser would be 

paid 40% less ($60) for selling the bond fund and 60% less ($40) for selling the Shortterm bond fund. 

These compensation differentials create a substantial economic incentive for a financial 

adviser to recommend more aggressive asset allocations to the 70-year-old retiree and 

other clients. The following table shows the commission/GDC/adviser payout for four 

different allocations. From the 

most to the least aggressive, the 

financial adviser’s total 

compensation declines 35%. 

Extrapolating to an annual salary, 

the adviser must choose between 

income of $100,000 or $65,000, or an income of $200,000 or $130,000. These distorted 

incentives are understated, however, because the combined effect of other types of

compensation differentials can be far more extreme.

To illustrate, consider the same investor making an investment of $35,000 instead of 

$10,000. Now the adviser has an additional conflict because some complexes offer 

discounts on commission at certain investment levels, known as “breakpoints.” For 

example, The American Fund provides a breakpoint at $25,000, at which point the 

commission on the entire investment drops from 5.75% to 5.00%, which would mean less 

compensation for the broker-dealer and the financial adviser. The financial adviser 

therefore has an incentive either to spread the investment among different complexes so 

as to fall under the $25,000 breakpoint, or simply to avoid funds with $25,000 
14

breakpoints. This would not be difficult. Breakpoints at $50,000 are quite common; they 

can be as high as $500,000.

The financial adviser also has an incentive to recommend funds that pay higher 

commissions. The American Fund’s 5.75% commission is typical, but many stock funds 

charge a 5.00% commission or less.20 The Cavanal U.S. Large Cap Equity Fund charges 

a 3.50% commission and pays a 3.25% GDC. Simply choosing The American Fund over 

the Cavanal Fund for a $10,000 investment would alone increase the financial adviser’s 

compensation by 54% (from $130 to $200).

The financial adviser also has an incentive to recommend funds that pay a higher GDC. 

For example, the DWS Capital Growth Fund charges a typical 5.75% commission, but 

shares 5.20% with broker-dealers rather than the more common 5.00%. On a $10,000 

investment, the extra 0.20% would generate $20 more for the broker-dealer and $8 more 

for the financial adviser. This might not seem like much, but DWS believes that this 

additional payment will help increase sales. Over billions of dollars in annual fund sales, 

these incentives add up.

In summary, financial advisers can more than double their compensation by opting for a 

more aggressive allocation to stock funds that have high commissions, high GDCs, and 

low breakpoints. The financial adviser’s compensation varies substantially where the 

time invested and level of analysis provided does not vary at all. The financial adviser’s

time and effort spent on choosing an asset allocation and fund complex is the same 

regardless of what allocation or complex is ultimately recommended. It is economically 

irrational for the adviser to be paid more to recommend an aggressive asset allocation 

over a conservative one, or for recommending one fund complex over another. The 

industry complains that the Department’s proposal will adversely affect small investors. 

In fact, the industry’s conflicted compensation causes the greatest harm to small investors 

 20 The average commissions for stock and bond funds are 5.4% and 3.8%, respectively. See ICI 2015 

Investment Company Fact Book at Figure 5.8. Cf. Robert Litan and Hal Singer, Obama’s Big Idea for 

Small Savers: ‘Robo’ Financial Advice, Wall. St. J. (July 21, 2015) (claiming that “small savers [pay] 

something like a 2% sales charge (or commission) up front when buying mutual funds.” (emphasis 

added)).
15

because they are most likely to purchase the shares that create the greatest conflicts. 

Small investors will benefit from the proposal more than other investors. 

The financial industry claims that removing such conflicted compensation structures 

would not be workable. However, some broker-dealers have already done so. For 

example, some have introduced “fee capping” whereby they limit the maximum 

commission that a financial adviser can receive on the sale, for example, of an emerging 

markets equity fund at 4%.21 In other words, we know that eliminating incentives to 

provide bad advice is workable because it is already working. The Department’s 

proposal is intended to bring about precisely this kind of reform. 

Differential commissions represent only one way that financial advisers’ 

recommendations are improperly conflicted. Financial advisers may also receive 

different levels of 12b-1 fees depending on the fund complex selected. They receive 

different financial benefits as a result of choosing fund complexes that pay higher 

revenue sharing than other complexes. The potential doubling of compensation described 

above grows larger as one type of improper financial incentive is stacked on another.

One of the most egregious forms of compensation incentives is the ratcheted payout grid. 

As financial advisers generate more GDCs, their payout percentage rises. For example, 

at $300,000 of GDCs over the preceding 12 months, an adviser’s payout percentage 

might increase from 32% to 42% of GDCs, as is the case, for example, for a Janney 

Montgomery Scott payout grid.22 However, this increase does not apply only to the 

 21 See Report on Conflicts of Interest, FINRA at 30 (October 2013) (“Report on Conflicts of Interest”) (“In 

the context of mutual fund and variable annuity sales, an effective practice FINRA observed is firms’ use 

of “fee-capping” to reduce incentives for a registered representative to favor one product family over 

another for comparable products. In a fee-capping arrangement, a firm caps the GDC that can be credited to 

a registered representative’s grid. Any GDC in excess of the cap accrues to the firm. For example, a firm 

may cap at 4 percent the GDC for emerging market equity funds. This would eliminate incentives for a 

registered representative to favor a mutual fund that paid a higher GDC than the 4 percent. It would not, 

however, eliminate the potential incentive for the registered representative to recommend a fund with a 4 

percent as opposed to a 2.5 percent GDC.”) available at 

http://www.finra.org/sites/default/files/Industry/p359971.pdf.

22 The Janney Montgomery Scott payout grid appears at page 7 of my written submission to the Department 

at http://www.dol.gov/ebsa/pdf/1210-AB32-2-WrittenTestimony28.pdf. For a general discussion of the 

structure of payout grids, see Report on Conflicts of Interest, supra, at 27 – 28. 
16

GDCs at $300,000 and above. Rather, the 10 percentage point increase in the payout also

applies to the previous $299,000 in GDCs. This ratcheted compensation structure means 

that a financial adviser has an additional incentive of $29,000 (10% of the first $299,000 

in GDCs) to recommend that his next sale generate enough commissions to get to 

$300,000 for the preceding 12 months. In other words, how the adviser recommends that 

a $20,000 investment be allocated will determine whether the adviser is paid an

additional $29,000. As shown in the chart below, an effective commission of 2.00% for 

the financial adviser (40% of the 5.00% GDC) 

on a $20,000 investment in a stock fund is 

turned into an effective commission in excess of 

150% of the amount invested. Will the adviser 

sell the short-term bond fund and be paid $120? 

Or will he sell the stock fund and be paid 

$30,180? It is truly remarkable that the 

Commission and FINRA allow broker-dealers to 

offer such financial incentives for their financial 

advisers.23

Indeed, this example illustrates where the Department’s position is far too tame. The 

Department suggests that, under its proposal, broker-dealers consider “effective policies 

and procedures relating to an Adviser’s compensation for broker-dealers,” including 

“[a]voiding creating compensation thresholds that enable an Adviser to increase his or 

her compensation disproportionately through an incremental increase in sales.” 

Ratcheted payout grids such as the one applied by Janney Montgomery Scott should be 

 23 While FINRA has noted such extreme incentives, but it has not prohibited them or, to my knowledge, 

taken any enforcement action regarding them. See Report on Conflicts of Interest, supra, at 28 - 29 (“Some 

firms apply a broker’s payout percentage on a retroactive basis. . . . In the context of compensation grids, 

paying a registered representative a higher percentage of gross revenue may legitimately reward effective 

and hard workers and encourage higher productivity. A conflict is created, however, if a representative’s 

desire to move to a higher payout level influences the number or type of recommendations he makes to 

customers. This conflict may be heightened when there is a relatively large increase in the percentage 

payout between revenue tranches; when there is a high probability that a few, incremental sales will move a 

registered representative to a new payout level; or where increased payout percentages are applied 

retroactively once a threshold is satisfied.”). Nor were these extreme financial incentives mentioned in 

FINRA’s most recent 2015 Regulatory and Examination Priorities Letter dated January 1, 2015. Available 

at http://www.finra.org/industry/2015-exam-priorities-letter#1.
17

per se prohibited. While that firm and others would likely complain that eliminating such 

structures would not be “workable,” this claim would beg the question as to how some 

broker-dealers find it workable to use payout grids that are not based on production at 

all.24

III. The Department’s Proposals are Eminently Workable and Already Working

The Department’s has proposed rules that are, notwithstanding claims by industry, 

eminently workable. Industry sophists claim that they cannot comply with the rules 

while also receiving commissions and that they will be forced, as a result, to require 

investors to enter into asset-based fee arrangements. However, these claims are not 

supported by the facts or the actual terms of the Department’s proposal. 

The industry is correct that, under the Department’s proposal, a financial adviser’s 

investment recommendation made to a retail investor regarding retirement assets will 

trigger fiduciary status, as it should, which would render a subsequent transaction a 

violation of the prohibited transaction rules if the financial adviser could receive 

differential compensation in connection with the recommendation (e.g., higher 

compensation for a transaction in one available product than another). There is nothing 

unusual about fiduciary status triggering prohibited transaction rules. There are many 

instances in which common business practices run afoul of ERISA’s prohibited 

transaction rules, but the Department has adopted exemptions from these rules, subject to 

certain conditions, that have been quite workable and made ERISA a workable statute.

For example, a retirement plan administrator that is a plan fiduciary cannot be paid fees 

by the plan and also receive 12b-1 fees from mutual funds that are investments options in 

the plan. However, the Department has taken the position investments in 12b-1 fee funds 

are permitted provided that the plan fiduciary offsets the fee it receives from the plan by 

 24 See Report on Conflicts of Interest, supra, at 28 (“Several firms with which FINRA met do not use a grid 

structure based on production. Some of these firms base payout percentages on a registered representative’s 

years of service.”).
18

the amount of the 12b-1 fees it receives from the funds.25 This exemption is relevant here 

because it involves precisely the kind of fee leveling that firms that service plans have 

found workable for years, yet these same firms now claim that fee leveling in the retail 

context cannot work.

Rather than explain exactly how complying with the Department’s proposal would 

actually affect their business practices, industry participants have generally adopted a 

strategy of insisting that the Department’s proposal would put them out of business. The 

industry makes generalized assertions that the Department’s standards are impossible to 

understand or comply with, when in fact their operation is self-evident and compliance 

requirements are clear. What is truly not “workable” for investors is paying financial 

advisers more for recommending one transaction than another when there is no reason to 

receive higher compensation other than to receive higher compensation. This is 

economically irrational and, as a policy matter, indefensible. The effect is an annual net 

social cost in the billions, a huge, wasteful transfer of wealth from uninformed, 

unsophisticated investors to deeply conflicted financial advisers.

Rather than acknowledging the blatant compensation conflicts discussed above and 

proposing effective alternatives to eliminating or mitigating them, the financial services 

industry has generally followed a public strategy of misrepresenting the operation and 

effect of the Department’s proposal. Many of the same practices that the industry claims 

are not “workable” have been adopted (and made workable) by broker-dealers. The 

following discussion identifies and rebuts many of the baseless claims that have been 

made regarding the Department’s proposal and provides examples of practices deemed 

not “workable” that some broker-dealers have nonetheless already adopted.

• Broker-dealers could receive compensation only if the compensation is level for 

all possible recommended transactions. The Department’s proposal would 

require fee leveling only for fees paid to the financial adviser, and even then in 

limited circumstances. It would not require any change in compensation received 

 25 See PTE 77-4 (April 8, 1977); DOL Advisory Opinion 93-13A (April 27, 1993); PTE 98-25 (June 9, 

1998). See also EBSA Press Release (Aug. 23, 2012) (settling charges against ERISA fiduciary adviser for 

receiving 12b-1 fees and revenue sharing payments) available at 

http://www.dol.gov/opa/media/press/ebsa/EBSA20121753.htm.
19

at the firm level. Nor would it require any change in compensation paid at the 

branch manager level if the branch manager does not make recommendations to 

clients.

• Broker-dealers and financial advisers would be required to sell the lowest cost 

product and would be prohibited from selling the highest cost product. The 

relative cost of different products is irrelevant to the Department’s proposal, 

which goes to financial advisers’ financial incentives to sell products and the 

compensation they receive, not the cost of products to investors.

• Broker-dealers’ and financial advisers’ compensation would be required to be 

identical for all products. As noted, broker-dealers’ compensation is unaffected 

by the proposal. The Department has stated explicitly that financial advisers are 

permitted to be paid more for selling products based on neutral factors, e.g., 

products that require more time or analysis, and for platform products (see 

below).

• Broker-dealers and financial advisers could not be paid higher compensation 

for selling variable annuities. The Department’s proposal would permit higher 

fees to be charged for selling variable annuities. The proposal explicitly states 

that higher fees paid for selling variable annuities would be justified by the 

additional time and analysis required when selling more complex products. Even 

if product-neutral compensation were required, there are broker-dealers that have 

demonstrated this approach is workable.

26

• Broker-dealers and financial advisers could not be paid higher fees for 

“platform” funds that pay up for shelf space. The Department’s proposal 

expressly permits broker-dealers and financial advisers to be paid higher 

compensation for selling platform funds. Even if higher compensation for selling 

platform funds were prohibited, there are broker-dealers that have demonstrated 

that not favoring platform funds is workable.27

 26 See Report on Conflicts of Interest, supra, at 29 (“An effective practice FINRA observed was firms using 

‘product neutral’ compensation grids to reduce incentives for registered representatives to prefer one type 

of product over another.”). 

27 See id. at 30 (“An effective practice is that for comparable products, firms not provide higher 

compensation, or provide other rewards, for the sale of proprietary products or products from providers 

with which the firm has entered into revenue-sharing agreements. The firms with which FINRA met each 

stated that their registered representatives are not compensated more highly for the sale of comparable 

proprietary or preferred provider products.”).
20

• Broker-dealers and financial advisers could not be paid higher fees for selling 

proprietary funds. The Department’s proposal specifically authorizes the sale of 

proprietary fund under broker-dealers’ existing business models, even if the funds 

offered are limited to proprietary funds. The proposal would not prohibit offering 

only proprietary funds, but some broker-dealers have demonstrated that this 

would be a workable approach.28

• The requirement for financial advisers to provide advice “without regard” to 

their own financial interests would be impossible to apply in practice because it 

would prevent an adviser from negotiating its own fees and/or would otherwise 

be unworkable. The Department’s proposal has no effect on a fiduciary ability to 

charge a fee, or to charge a higher fee than its competitors, just as ERISA 

fiduciaries have been permitted to negotiate higher fees for decades. It is selfevident that the “without regard” requirement would only prevent a financial 

adviser from being paid more for making one recommendation than another, and 

then only if the differential does not reflect neutral criteria and is significant 

enough to prevent a recommendation from being made without regard to the 

differential. This means, for example, that a financial adviser could not be paid 

more for recommending one domestic large cap fund over another if the fund 

recommended generates higher compensation for the adviser. The “without 

regard” standard is identical to the “without regard” standard in Section 913 in 

Dodd-Frank Act, under which the industry now urges the Commission to enact 

rules while arguing that the same “without regard” standard as promulgated by the 

Department could not work.

• The prohibition against providing incentives to financial advisers that “tend to 

encourage” advice that is not in the client’s best interest would not be workable 

and/or is not sufficiently clear. As with the “without regard” standard, the “tend 

to encourage” standard clearly applies only to financial incentives that have no 

purpose other than to encourage sales of products that generate higher revenues 

for the financial adviser and broker-dealer. Compliance is simple. Broker-dealers 

need only level compensation paid to financial advisers where there are no neutral 

factors that explain the compensation differential on some basis other than 

incentivizing sale of a higher compensation product. When the only basis for 

differential compensation is to incentivize the sale of the higher compensation 

product, a firm may run afoul of the proposed rules, as it should.

• Broker-dealers and financial advisers could not comply with the “reasonable 

compensation” requirement. The prohibited transaction exemption on which 

broker-dealers currently rely in conducting transactions subject to ERISA, PTE 

86-128, already imposes a reasonableness condition.

29 The industry has 

 28 See id. 

29 See Class Exemption for Securities Transactions Involving Employee Benefit Plans and Broker-Dealers, 

Prohibited Transaction Exemption 86-128 (exemption for reasonable compensation received by fiduciary 

for effecting or executing agency cross transaction).
21

considered this reasonableness requirement to be “workable” for years.30 

Moreover, the requirement that compensation be “reasonable” means only that it 

be within range of fees typically charged for similar products and services. This 

is exactly how the Commission has applied the “reasonable” commissions 

requirement under the Investment Company Act for decades,31 and the financial 

services industry has found this standard to be “workable.” Even the Securities 

Industry and Financial Markets Association (“SIFMA”) has proposed a 

“reasonable fee” requirement.32

• Broker-dealers and financial advisers would be forced to move small investors 

into accounts that charge asset-based fees because commissions could not be 

charged. As explained above, the Department’s proposal would not prohibit 

commission-based compensation. Investors therefore would not be forced to 

move to other compensation models. They would only be forced to receive less 

conflicted advice that was not in their best interest.

• The U.K. adopted similar reforms and those reforms have had an adverse effect 

on investors. Both of these claims are false. The U.K. reforms are not similar to 

the Department’s proposed reforms. For example, the U.K. banned product-based 

commissions.33 As is clear in the Department’s proposal and as explained above, 

the Department has not proposed to ban commissions. Broker-dealers will 

continue to be permitted to charge commissions. There is also strong evidence 

that the U.K. reforms have had a positive net effect on investors.34

In summary, the industry’s principal complaints regarding the Department’s rulemaking 

are unfounded. In many instances, broker-dealers have adopted fee leveling and other 

 

30 Ameriprise Comment Letter at 6 (June 20, 2015) (describing PTE 86-128 as a “workable” exemption) 

available at http://www.dol.gov/ebsa/pdf/1210-AB32-2-00560.pdf.

31 The Investment Company Act prohibits fund affiliates from acting as brokers for a mutual fund if the 

remuneration paid “exceeds (1) the usual and customary broker’s commission if the sale is effected on a 

securities exchange.” ICA § 17(e)(2)(A). In Rule 17e-1, the Commission has interpreted “usual and 

customary” to mean “reasonable and fair compared to the commission, fee or other remuneration received 

by other brokers in connection with comparable transactions involving similar securities being purchased or 

sold on a securities exchange during a comparable period of time.” ICA Rule 17e-1(a).

32 SIFMA’s proposal (“SIFMA Proposal”) can be downloaded at: 

http://www.sifma.org/issues/item.aspx?id=8589954937 (last visited Sep. 5, 2015).

33 See Distribution of Retail Investments: Delivering the RDR - Feedback to CP09/18 and Final Rules, 

U.K. Financial Services Authority at 4 (March 2010) (“Once the rules come into effect, adviser firms will 

no longer be able to receive commissions set by product providers in return for recommending their 

products, but will have to operate their own charging tariffs in accordance with our new rules.”) (emphasis 

added). In the United States, fund commissions are, by law, fixed by fund companies.

34 See Sean Forbes, U.K., Others Provide View of Fiduciary Rule Impact, Pension & Benefits Daily (Aug. 

31, 2015) (citing studies).
22

conflict-neutralizing practices that go further than would be required by the Department, 

yet industry lobbyists claim that these practices would be impossible to implement. 

These practices include: (1) eliminating financial advisers’ differential compensation for 

platform and proprietary funds, (2) capping commission compensation for financial 

advisers, (3) adopting product-neutral commissions and payout grids, (4) abjuring 

production-based payout grids altogether, and (5) limiting payout increases to prospective 

sales rather than also applying them retroactively.

IV. Alternative Proposals 

A number of alternatives to the Department’s proposals have floated by industry 

members and special interest groups. I discuss some of them below. One feature they 

generally lack is a fiduciary duty for financial advisers who provide retail investment 

advice. A fiduciary duty applies to an adviser’s compensation. The Fidelity proposal 

specifically exempts an adviser’s compensation from being subject to a fiduciary duty. A 

fiduciary duty incorporates a duty of loyalty. Neither SIFMA’s nor the Financial 

Services Roundtable’s proposal imposes a duty of loyalty. The following proposals are 

not workable alternatives to the Department’s proposals for addressing conflicted 

compensation arrangements. 

A. Fidelity Proposed Alternative 

Fidelity’s principal objection to the Department’s proposal is as follows: 

the rule proposal makes an advisor a fiduciary with respect to 

establishment of its own services and compensation. This is both 

unprecedented in fiduciary law and not commercially viable, potentially 

requiring an advisor to recommend its competitors over itself even if its 

own services are wholly appropriate for the investor.35

While Fidelity is correct as to the effect of the proposal, it is not correct that subjecting an 

 35 Fidelity Comment Letter (July 21, 2015), available at http://www.dol.gov/ebsa/pdf/1210-ZA25-

00157.pdf.
23

adviser’s or other person’s fees or services is unprecedented or not commercially viable. 

Trustees, under trust law, have been subject to a fiduciary duty with respect to their fees 

and services for centuries. Investment advisers, under the Investment Advisers Act, have 

been subject to a fiduciary duty with respect to their fees and services for decades. And 

fiduciaries under ERISA, including Fidelity, have been subject to a fiduciary duty with 

respect to their fees and services for decades, although the Department has granted many 

exemptions to make firms’ obligations workable under ERISA. In each case, trustees, 

investment advisers and ERISA fiduciaries have found compliance with their duties to be 

commercially viable, and they have never had to recommend a competitor over 

themselves.

In fact, for decades financial advisers who act in a discretionary capacity or have a 

relationship of trust and confidence with their clients, including Fidelity financial 

advisers, have been subject to a fiduciary duty.36 The most common claim made in 

arbitration against financial advisers is breach of a fiduciary duty.37 Thus, Fidelity’s 

recommendation that advisers not be subject to a fiduciary duty with respect to their fees 

flatly contradicts current law and reflects a standard that is lower than the current legal 

standard as applied to advisers under securities law. 

 36 See, e.g., United States v. Wolfson, 642 F.3d 293 (2d Cir. 2011) (“Although we have long held that there 

“is no general fiduciary duty inherent in an ordinary broker/customer relationship,” we have also 

recognized that “a relationship of trust and confidence does exist between a broker and a customer with 

respect to those matters that have been entrusted to the broker.” ... [A] discretionary account is not the sole 

means by which a fiduciary duty may be created in the context of a broker-customer relationship; we have 

“recognized that particular factual circumstances may serve to create a fiduciary duty between a broker and 

his customer even in the absence of a discretionary account.” ... Put otherwise, it is well settled in this 

Circuit that the presence of a discretionary account automatically implies a general fiduciary duty between 

a broker and customer, but the absence of a discretionary account does not mean that no fiduciary duty 

exists.”).

37 Fiduciary duty breach claims have been the most common every year at least from 2008 through 2014. 

See Dispute Resolution Statistics, Fin. Indus. Regulatory Auth., available at http:// 

www.finra.org/ArbitrationAndMediation/FINRADisputeResolution/AdditionalResources/ Statistics/ (last 

visited Sep. 5, 2015); Mercer Bullard, The Fiduciary Standard: It’s Not What It Is, But How It’s Made, 

Measured and Decided, 87 St. John’s L. Rev. 337, 369 – 78 (2013) (discussing arbitration). Arbitration 

panels are not required to explain the basis of their decisions, so it is unknown how often they find a breach 

of a fiduciary duty. However, on occasion a panel will reveal its reveal its findings. See, e.g., Billings v. 

Merrill Lynch, Pierce, Fenner & Smith Inc., FINRA Arbitration No. 11-01948 (Oct. 12, 2012) (finding 

respondent violated fiduciary duty to claimants and awarding monetary relief) available at

http://finraawardsonline.finra.org/viewDocument.aspx? DocNb=59344.
24

What Fidelity may mean is that it disagrees with the effects of being a fiduciary under 

ERISA, which are certainly different from the effects of being a fiduciary in other 

contexts. But its blanket statement that it is “unprecedented” to subject an adviser to a 

fiduciary duty with respect to their fees and services is simply incorrect. It is not 

unprecedented. It is quite common. 

Fidelity’s proposal is to separate the adviser’s fees and services from its 

recommendations. The financial adviser’s recommendations would be subject to a best 

interest standard, but conflicted compensation would not. Thus, Fidelity’s proposal does 

not create a fiduciary duty with respect to conflicted compensation that tends to 

encourage the sale of higher cost products. The conflicted compensation arrangements 

that Fidelity’s proposal would exempt from being subject to a fiduciary duty are precisely 

the conflicts that are the raison d’etre of the Department’s rulemaking. 

Fidelity equates the situation where a “person who is already providing investment advice 

to a plan ‘persuades’ a plan fiduciary to extend his contract at a higher fee” to financial 

advisers’ compensation, arguing that “[t]here is no reason why this concept should not 

apply where the advisor’s compensation varies based on the transactions and services 

recommended.” Actually, there is a very good reason. Conflicted compensation is not 

about paying more or less for a given set of services or negotiating a higher fee. It is 

about compensation for a given set services – investment recommendations – that varies 

based on the recommendation made by the adviser. A doctor, lawyer or priest can 

negotiate a higher fee or salary consistent with their fiduciary duties. However, a doctor 

should not be paid more for an office visit for recommending one drug over another. A 

lawyer should not be paid more for interpreting the law one way rather than another. A 

priest should not be paid more for giving one kind of spiritual advice over another. 

Fidelity’s comparison to negotiating a higher fee misses the point. 

Fidelity’s second primary objection to the proposal is that it is “unworkable.” As 

discussed above, the proposal is eminently workable. Although Fidelity has provided a 

number of constructive comments and recommendations regarding how to improve the 
25

proposal in its comment letter, its suggested alternative approach is inadequate because it 

simply does not regulate conflicted compensation practices.

B. SIFMA Proposed Alternative 

The Securities Industry and Market Association (“SIFMA”) has proposed as an 

alternative to the Department’s rulemaking that comprises only a set of amendments to 

FINRA rules.38 In other words, SIFMA is opposed to broker-dealers being ERISA 

fiduciaries. Its proposal does not address non-securities, over which FINRA has no 

jurisdiction. Its proposal rejects the foundational premise of ERISA that retirement assets 

are deserving of more protection than other assets. Its proposal does not provide a 

reasonable alternative.

SIFMA claims that the Department’s proposal creates an “additional standard of care.” 

That is incorrect. The Department has stated that a recommendation that may trigger 

fiduciary status is a recommendation as determined under FINRA rules. FINRA rules 

already impose a suitability 

standard. As the table on 

the right illustrates, the 

Department has essentially 

adopted FINRA’s

suitability duty of care 

standard. The table makes

it clear that the Department 

has not proposed an

“additional” standard of 

care.”

SIFMA’s proposal would have no effect on conflicted compensation arrangements. It 

would require that these arrangements be “managed” and that steps be taken to ensure 

 38 See SIFMA Proposal, supra.
26

that recommendations are not “materially” compromised by “material” conflicts of 

interest. However, FINRA has made it clear that it does not object to blatant conflicts of 

interest that violate current FINRA rules. SIFMA prefers that federal securities 

regulators tacit approval of conflicted compensation arrangements set the bar. As the 

above description of conflicted compensation arrangements demonstrates, the status quo 

is unacceptable. 

SIFMA contends that there should be a uniform fiduciary duty for all retail brokerage

accounts, that it should “serve as a benchmark for, be consistent with, and integrate 

seamlessly into, the SEC uniform fiduciary standard that ultimately emerges under DoddFrank § 913,” and that it should “follow the traditional securities regulatory approach.” 

Congress could satisfy SIFMA’s wishes in this respect, but the Department cannot. 

Congress specifically decided in enacting ERISA to impose a higher duty with respect to 

retirement assets than to other accounts subject only to securities regulation, and to 

impose that standard to non-securities (a distinction that SIFMA ignores). Congress 

specifically included IRAs as covered retirement assets. SIFMA’s wishes do not run 

contrary to the Department’s proposal. They run contrary to the statute that the 

Department is required to apply.39 SIFMA, like FINRA, disagrees with the fundamental 

premise on which ERISA is based, that Americans’ retirement security deserved 

heightened protection.40

SIFMA’s proposed amendments to FINRA rules do not impose a fiduciary duty on 

financial advisers and, in many respects, weaken existing standards applied by FINRA. 

Nor does SIFMA’s alternative provide for private enforceability, much less for a binding 

contractual commitment. For example, SIFMA proposes that investors be permitted to 

 39 SIFMA notes that “FINRA CEO Ketchum, in his remarks at the FINRA Annual Conference on May 27, 

2015, reinforced many of these same points. ‘It is not optimal,’ he stated, ‘to apply a different legal 

standard to IRAs and 401(k)s than to the rest of an investor’s assets.’” The same statements were made in 

FINRA’s comment letter to the Department. Subcommittee members should pay close attention to these 

statements. In both cases, FINRA not only has rejected a regulatory structure that has existed for decades, 

but also has cast doubt on its understanding of and willingness to enforce existing law. FINRA’s 

comments reflect the interests of private industry (its members), not the investors it is statutorily required to 

protect.

40 See id.
27

“waive” or “consent to material conflicts” of interest, which defeats the investor 

protection purpose of a fiduciary duty. The centuries-old purpose of a fiduciary duty is to 

protect investors who are vulnerable or at informational disadvantage, which impairs 

their appreciation of waiving their rights. SIFMA would require disclosure of material 

conflicts of interest without any requirement to disclose conflicted compensation, much 

less the amount of or differences in such compensation, which comprises less disclosure 

than is currently provided by most broker-dealers. SIFMA would deem all existing 

customers to have consented to “material conflicts of interest” based solely on such 

inadequate disclosure, thereby assuming consent where the investor has not actually 

consented.

C. FSR Proposed Alternative

FSR has proposed an alternative to the Department’s BIC exemption.41 However, 

although FSR claims to support a “best interest” standard and that its proposed PTE 

“codifies a best interest standard,” its alternative PTE does not apply a best interest 

standard. FSR would require that a financial adviser’s recommendation to a client: 

(i) reflects the care, skill, prudence, and diligence under the circumstances 

then-prevailing that a prudent person would exercise; and (ii) provides the 

Retirement Investor with an opportunity for an appropriate return, risk 

exposure, or benefit taking into account the Retirement Investor’s unique 

needs as disclosed by the Retirement Investor to the Adviser and/or

Financial Institution.

A fiduciary duty comprises a duty of care and a duty of loyalty. The FSR’s standard 

reflects a duty of care; it does not include a duty of loyalty. FSR’s PTE nowhere 

references a financial adviser’s duty of loyalty. The primary purpose of the Department’s 

proposal is not to establish a higher standard of care. It is to create a higher duty of 

loyalty, and to apply a kind of loyalty standard to compensation that improperly 

incentivizes financial advisers to sell higher compensation products. However, nothing 

in the FSR’s PTE would prohibit financial advisers from making recommendations based 

 41 FSR’s Simple Investment Management Principles and Expectations Prohibited Transaction Exemption 

begins on page 101 of FSR’s written submission to the Department in connection with its testimony on 

August 10, which can be accessed at: http://www.dol.gov/ebsa/pdf/1210-AB32-2-WrittenTestimony6.pdf.
28

solely on their own financial interests so long as such recommendations could be 

defended as being within the range of what is prudent. 

FSR’s proposal requires that firms adopt procedures to mitigate material conflicts of 

interest, but it defines “material conflict of interest” in a way that would expressly 

exclude conflicted compensation even it was likely to affect a financial adviser’s 

recommendation. FSR defines a “material conflict of interest” as a financial interest that 

creates a “substantial likelihood that a reasonable Retirement Investor would attach 

importance” to that interest in deciding whether to take or refrain from taking a particular 

action. This standard misses the point. The issue is not what is important to an investor. 

The question is not whether the investor would consider something important. The 

investor is not making an investment decision. The investor has decided to place his or 

her trust and confidence in the financial adviser. The issue, as even the SIFMA proposal 

expressly recognizes,42 is the likelihood that conflicts of interest will adversely affect

financial adviser’s recommendations. 

Nor is FSR’s “substantial likelihood” standard appropriate. If a conflicted compensation 

is “likely” – but not “substantially likely” – to affect a financial adviser’s 

recommendation, there is no question that the compensation should not be permitted. 

FSR’s position is that conflicted compensation that is “likely” to affect a financial 

adviser’s should be permitted. This position is indefensible.

FSR defines “recommendation” as comprising only an “explicit suggestion” that the 

investor engage in or refrain from engaging in a “specific transaction or transactions.” 

Financial advisers could easily frame their recommendations so as not to be “explicit” or 

“specific” so as never to trigger any of the PTE’s requirements. This definition conflicts 

with the meaning of “recommendation” under FINRA rules. 

Section V of FSR’s proposal would provide a blanket exemption for all compensation 

received in connection with the purchase of an investment prior to the PTE’s effective 

 42 See SIFMA Proposal, supra (requiring that recommendations “[a]void, or otherwise appropriately 

manage, disclose, and obtain consents to, material conflicts of interest, and otherwise ensure that the 

recommendation is not materially compromised by such material conflicts.) (emphasis added).
29

date. In other words, financial advisers could continue to advise a client, for example, to 

retain an investment that paid higher compensation even if it would be in the client’s best 

interest to switch to a lower cost investment. This standard is lower than FINRA’s 

current suitability standard, which applies to recommendations to hold investments, and, 

like many aspects of FSR’s proposal, ignores existing broker-dealer regulation.

Finally, FSR’s alternative does not create a contractually binding commitment for the 

paltry standards that it imposes. In arbitration proceedings, FSR’s proposal would give 

defendants a basis for arguing for a standard under the FSR PTE that is lower than the 

current standard under FINRA rules. In summary, the FSR standard would be worse than 

no standard at all.